Is there a Complete Business Case for Reverse Factoring?

By now, we know the horse has long left the barn on Reverse Factoring as a technique for large Fortune 500 companies to extend terms.  Many of the top global companies use their own credit to deploy a "funding option" for their “short tail” or key suppliers  to access Libor-based funding for their sales to them. So while they are hitting their suppliers with the stick, they offer the carrot.  Several articles, including the WSJ article in April 2013, have cited multiple companies generating hundreds of millions of dollars each in operating cash flow by using this technique to support their payment term initiatives

No doubt, reverse factoring benefits big buyers directly by extending their payment metric of DPO. Many companies will measure how much spend per cost of good sold has been successfully extended terms through the program.

But the impossible data to collect or measure is how does term extension come back in higher prices.

A vendor told me, “We tried to do that and its really, really hard.” Another vendor told me that while they have analyzed well over $1 trillion in corporate spend, they were not able to do this.

No doubt this would be very difficult to accomplish. Because anyone attempting to do a full blown analysis would not only have to look at the Fortune 500 company that spends $135M with their ingredient or grain supplier where they have extended terms from 30 to 45 days, but also if that action caused any increase in price during the next procurement negotiations.  Yes, difficult stuff for sure.

So what we are left with is to look at is the option value created for the supplier by participating in a program. Remember, these programs are not mandatory, and a company has the ability to opt-in when they want to.  What is the value of that option?  Can we analyze this option like we do with the Black-Scholes formula?    Option pricing is related to volatility, and I could imagine the more volatile access to liquidity is, the more valuable these programs are.  That would be a counterpoint to the cost of goods sold going up.

But just because this is hard doesn’t mean the industry should not attempt to get a better understanding. Because if you create a win for your Treasurer by extending DPO, you may eventually have to deal with a loss for your Procurement department as you have less payment leverage due to the extended terms.

What do others think? Has anyone seen good data on this?

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  1. Robert Kramer:

    David, really good question regarding Supply Chain Finance and the impact of term extensions on pricing. In my experience, almost every company considering SCF has asked this question. Can we put together a business case that looks at “total cost”, that is, a business case that includes the impact of term extensions on pricing in addition to cash flow.

    When developing a business case in advance of making a go/no go SCF decision, this can and should done on a theoretical basis as part of a rigorous working capital analysis based on various supplier characteristics and historical data. But you want to know the actual impact based on post rollout data.

    The good news is it’s actually quite easy for Buyer’s to do this, at least in the way you positioned the question. They know which suppliers received term extensions and they know the pricing before and after. Current SCF vendors can’t answer the question because they don’t have pricing data, unless they get it secondarily from the buyer as part of the provider’s implementation process.

    Another interesting question for me here is why are we only asking this question in the context of SCF? Corporates should already consider the total cost of price + terms or, as one of my clients calls it, holistic margin management.

    For example, Kellogg’s DPO is 20 days higher than General Mills and that gap is growing. Those 20 days cost General Mills $636 Million in operating cash flow! What is General Mills getting for its investment of $636 Million in paying suppliers early? Better pricing? I don’t know, but for what it’s worth, Kellogg’s gross margin is 36% and General Mills is 34%.

    Bob Kramer
    Partner, Working Capital Solutions & Trade Finance

    1. David Gustin:

      Hey Bob

      I dont think its all that easy to do a price comparison before and after and here’s why.

      First we know procurement and treasury rarely talk.

      Second and more importantly, without going into a pricing dissertation with buyers-suppliers, pricing is complex.

      Pricing contracts are characterized by the pricing method used, the duration of the contracts, the quantities to be supplied, and at its frequencies. You may have long term index linked prices, long term fixed price with reneg options, long term fixed price, pre order contract spot buys, and others.

      So I don’t buy this is a no brainer. I am sure you can get directionally correct data, and thats a good start.


      1. Bob Kramer:

        Hey David,

        My point was that it’s “easy for Buyers” to get the data, not that it’s easy for Treasury to get the data, so the quality of communication between Treasury and Procurement is irrelevant. Procurement has access to the data and they’re at the sharp end of the stick when it comes to executing against the term extension initiative.

        Regarding your second point. If you’re saying that pricing is so complex AND that the complexity is constantly changing such that you can’t compare one year’s pricing to the next then how does a company ever compare pricing? How do they know if they got a good price? How does Procurement know if they’re meeting their objectives? I could go on but what you’re saying is that, with or without Supply Chain Finance, Procurement can’t measure what in most cases is one of the most important aspects of their job. I don’t buy it. Procurement can compare pricing from contract to contract without SCF so I’m sure they can do it with SCF.

        Bob Kramer
        Partner, Capgenta

        1. David Gustin:

          You can certainly compare prices Bob, the point being how do you model for the effect of longer terms? There are so many other reasons why prices can change. So your analysis could be flawed and hence any further decisions based off the analysis.

  2. Antonio Salgueiro:

    Dear Watson, I would say that it all dependes if it is the treasurer only or also the business head to thank you. If the extra cash just relief treasury, without an economical impact, translated on increased sales, the positive effects of such programs may be offset by the increasing cost of sales. Still, your suppliers will thank you. Otherwise, if these result on extra business, the incresed purchases will sustain costs, margins will not be affected and results would increase proportionally. In this case, whenever taking advantage of the product ro extend terms, reverse will result whenever additional liquidity is re-invested in the supply chain and there’s a demand for the additional offer. But this is just part of the reverse potential. This doesn’t necessarily extend terms. In fact it often gives suppliers the possibility to anticipate payments an inferior cost of average funding, based on the better risk of the buyer, otherwise they will not use it. in such case, the gain would be evident for the buyer. Halfway, it’s a win win.

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